Financial District

The “donor” or “donee” debate still ignites controversy when it comes to the Highway Trust Fund. Did your state ‘donate” (give more in fuel and other highway user taxes and fees) to Washington than it got back, or did you state get back more than it gave?

The big and rich states have complained that they are subsidizing other states to the detriment of their own roads, and Senator Kay Bailey Hutchison (R-Tex) has pushed legislation to allow states to opt out of the HTF.

But a new study by the Government Accountability Office (GAO) shows that nearly all states have gotten back at least as much money from the HTF as they contributed since 2005.

Ironically, the lone exception was Texas which received slightly less than a dollar – 99.7 cents – for every dollar its highway users paid into the system. Other states’ returns per dollar ranged from $1.02 for Arizona to $5.63 for D.C. Of the remaining states, only Alaska at $4.92 topped the $4 mark and five states received between $2 and $3 for every dollar of input.

“In addition, all states, including Texas, received more funding than their highway users’ contributed during both fiscal years 2007 and 2008,” said the report. “In effect, almost every state was a donee state during the first fours years of the current transportation law “(SAFEYTEA-LU).

This was possible because more funding was authorized and apportioned than was collected from the states. The reference is to the almost $30 billion of general revenue channeled to the HTF by Congress since 2008 as the fund staved off bankruptcy largely because more funding was authorized than collected.

Current transportation law includes an equity bonus designed to guarantee states a minimum return. The Equity Bonus Program was used to address rate-of-return issues. It guaranteed about $44 billion. Nearly all states received Equity Bonus funding and about half received a significant increase, at least 25 percent, over their core funding. In effect, the bonus balances donor/donee status by disproportionately using the fund to lift donor states up to equity.

If the percentage of funds states contributed to the total is compared with the percentage of funds states received (i.e., relative share), then 28 states received a relatively lower share and 22 states received a relatively higher share than they contributed. Thus, depending on the method of calculation, the same state can appear to be either a donor or donee state, said the report.

But the report also highlights some of the problems that come with general fund infusions and with the requirement that the HTF be tied to a rate of return.

The report notes that the infusion of general revenues into the Highway Trust Fund affects the relationship between funding and contributions. “Using rate of return as a major factor in determining highway funding poses challenges to introducing a performance and accountability orientation into the highway program; rate-of-return calculations in effect override other considerations to yield a largely predetermined outcome – that of returning revenues to their state of origin. Because of these and other challenges, funding surface transportation programs remains on GAO’s High-Risk list.”

The report bluntly highlights a problem: “Adding general revenues into the trust fund and other challenges raise questions about relying on states’ rate-of-return to distribute federal highway funds.”

In addition to outside (general fund) funding, the report identifies two other wild cards that influence the amount and percentage of funds received: One is “the challenge of factoring performance and accountability for results into transportation investment decisions;” and two is “the long-term sustainability of existing mechanisms and the challenges associated with developing new approaches to funding the nation’s transportation system.”

The key to the problem is not hard to find; in fact, the report states it quite succinctly: “… the infusion of significant amounts of general revenues into the Highway Trust Fund Highway Account breaks the link between highway taxes and highway funding.” This is the problem that is worrying lobbyists and associations pushing hard for reauthorization. They fear that if an infusion from the general fund comes to be considered a common practice, then opponents of the HTF will claim the need for it has passed.

There is another problem: “The infusion of a significant amount of general fund revenues complicates rate-of-return analysis because the current method of calculating contributions does not account for states’ general revenue contributions. For many states, the share of Highway Trust Fund contributions and general revenue contributions are different, therefore state-based contributions to all the funding in the Trust Fund are no longer clear.”

The rate-of-return formula poses yet another problem when it comes to trying to factor performance and accountability into transportation investment decisions.

Incorporating performance and accountability for results into transportation funding decisions is critical to improving results. However the current approach presents challenges. Says the report, “…incorporating performance and accountability for results into transportation funding decisions is critical to improving results. However the current approach presents challenges. The Federal-Aid Highway program, in particular, distributes funding through a complicated process in which the underlying data and factors are ultimately not meaningful because they are overridden by other provisions designed to yield a largely predetermined outcome – that of returning revenues to their state of origin.”

In other words, trying to meet the rate of return criteria leaves little or no room to allow for performance and accountability factors. The Washington complaint as the GAO sees it in this report is that once the money is out of their hands they have previous little control over when, where and how it is spent.

So, how do you change that?

Well, the GAO says it’s trying: “For three highway programs that were designed to meet national and regional transportation priorities, we have recommended that Congress consider a competitive, criteria-based process for distributing federal funds.”

The report notes that with, “many surface transportation programs, goals are numerous and conflicting, and the federal role in achieving the goals is not clear. Many of these programs have no relationship to the performance of either the transportation system or of the grantees receiving federal funds, and do not use the best tools and approaches to ensure effective investment decisions.”

Performance and accountability for results must be considered in transportation funding standards. But according to the GAO, the need to return revenues to their state of origin overwhelms that process.

In the end, the report recognizes the inevitable: “A fund that relies on increasing the use of motor fuels to remain solvent might not be compatible with the strategies that may be required to address these challenges.” This of course raised a sequential question: If not the HTF, what? The GAO argues that in the near future policy discussions will need to consider what the most adequate and appropriate transportation financing systems will be and “whether or not the current system continues to make sense.” v

We decry the decrepit state of our “crumbling” infrastructure, but we have yet to adopt legal rules needed to provide for its ongoing maintenance and repair.

A glance at the law governing enforcement of municipal bond obligations suggests a possible strategy for solving the maintenance problem, one that could be developed by state and local officials, bond lawyers, and other financial professionals.

Despite the drift of political and editorial rhetoric, the solution here is probably not to increase federal spending. Rather, it probably lies in the more tedious exercise of changing state and local finance laws nationwide to give maintenance spending the same priority, the same legal protection from political plunder, as debt service. This, even though maintenance spending is usually considered part of the annual operating budget separate and distinct from payments to bondholders.

Typically, bondholders are a “permanent” minority. In James Madison’s terms, they are a “faction” of lenders, always outnumbered by the (debtor) faction of voters. If bondholders had to rely for payment on the annual budget log-roll, they would, like any other permanent minority, almost always lose. They would need constitutional safeguards or other effective protection. Indeed, it’s precisely the existence of constitutional protection — or in some cases, an equivalently sturdy economic incentive — that permits states and localities to attract long-term lenders to finance capital projects.

Throughout the late 19th and most of the 20th centuries, bondholders relied largely on the non-impairment provision of the contract clause of the Constitution (and similar interpretations of state constitutions) for protection of their interests. Courts would generally enforce debt-service payment obligations against states and localities, even in the face of periodic political decisions to the contrary.

In the late 19th century, for instance, the docket of the U.S. Supreme Court was crowded with municipal bond enforcement cases. And not too long ago, in 1977, the contract clause protected covenants barring mass transit spending by the Port Authority of New York and New Jersey in the U. S. Trust case.

For more than a century, legal enforceability induced lenders to bear political risks that could result not only in payment default but also in a covenant breach. The muni bond market flourished and grew.

More recently, as shown by the explosive growth of “subject-to-appropriation” or “back-door” credits — where a legal obligation to pay arises only after an appropriation has been made in the fiscal period when payment is due — bondholders have come to rely on the expected draconian consequences of “repudiation” by a (sovereign) state.

If a state should fail to appropriate debt service for an authorized subject-to-appropriation credit, then, for all practical purposes, the market would consider that to be a repudiation of the state’s own debt. As a result, the state would lose access to credit markets, at least until the repudiation itself was repudiated by full payment. Loss of access is an altogether unacceptable risk, one imposing essentially the same payment discipline as legal enforceability.

For locals, markets generally don’t accept repudiation risk as an effective safeguard for long-term lending, in part because locals are in no relevant sense sovereign in our federal system, and in part because no one can confidently predict what they may do. After all, Los Angeles is now boycotting Arizona, and the West 67th Street Block Association in New York City once had its own foreign policy.

Those factors raise two questions about infrastructure maintenance:

Are supporters of current maintenance those who oppose “deferred maintenance,” a permanent minority in need of constitutional protection in our political system, just like bondholders themselves?

Are special projects like limited-access highways and toll bridges — which produce cash revenue to pay bondholders and where that cash is not normally required to be spent only in the budget appropriation process — in a different analytical position from ordinary infrastructure projects like local roads, bridges, schools, and parks, which produce no cash revenue and where general obligation or other tax-supported bondholders get paid even if the project falls apart?

As to the first question, deferred maintenance is hardly a laudable public-policy goal, despite the pledge of one desperate candidate to be the veritable champion of deferred maintenance. Rather, deferred maintenance is to be avoided if all that crumbling infrastructure is to be avoided.

No one can tell when maintenance is deferred, without granular expertise in capital and operating budgets. As a result, the repudiation risk has no bite. Everyone wants infrastructure to be maintained, but everyone also has multiple higher priorities. No special interest groups or political action committees organize around pro-maintenance slogans. Indeed, interest groups frequently target funds otherwise earmarked for maintenance as a funding source for their own wages, benefits, or transfer payments. Also, few ribbon-cutting photo-ops are held to herald maintenance programs.

So, yes, proponents of current maintenance and opponents of deferred maintenance constitute a permanent minority in need of constitutional protection in the normal budget process.

For the second question, comparing how we finance revenue-generating projects with how we finance ordinary infrastructure suggests a fix. Revenue bond indentures effectively protect maintenance requirements as if they were debt-service requirements by building the former into coverage ratios for the latter. Investors fear projects that are not maintained will fail to generate the requisite revenue to pay debt service.

Generally, no money is released from the lien of a revenue bond indenture unless debt service is paid and operations and maintenance requirements are met. Enforceable covenants require issuers to raise tolls, fares or other charges sufficiently to meet both those requirements.

By contrast, GO and other tax-supported debt instruments are not generally issued with enforceable claims for current maintenance. Ordinary infrastructure projects produce returns in the form of public goods, not cash — public goods that benefit taxpayers, not bondholders. Those projects’ bonds are paid for by taxpayers, not direct users, and taxing and spending for payment are part of the annual budget process, where any pro-maintenance lobby is a perpetual minority.

So, yes, we should consider reconfiguring state and local finance laws, jurisdiction by jurisdiction, to provide the equivalent of debt service protection for maintenance requirements, by authorizing financing mechanisms for ordinary infrastructure that recognize enforceable claims for current maintenance and repair. This would entail authorizing a parallel structure to a revenue-bond financing structure.

The aim here would be for budget-makers to provide for maintenance spending, along with debt service spending, before recognizing other claims on annual revenue. A one-size-fits-all model or uniform law would probably not work for 50 states.

This is not to suggest that maintenance claims are more important than the compelling and competing claims of teachers, police, or sick children. It is, however, to suggest that maintenance claims — like the claims of bondholders — are unlikely ever to be met in the normal political process without structural fiscal safeguards. So, unless we change the rules of the game, we’ll probably have to live with our “crumbling” infrastructure.

Editor’s Note: Eugene W. Harper Jr., a retired New York bond lawyer, teaches infrastructure finance at the Baruch College, City University of New York, School of Public Affairs. This article ran originally in The Bond Buyer newspaper. Bond Buyer is a SourceMedia publication. SourceMedia is owned by Investcorp, which also owns Randall-Reilly, the parent company of Better Roads.

Financial District

The “donor” or “donee” debate still ignites controversy when it comes to the Highway Trust Fund. Did your state ‘donate” (give more in fuel and other highway user taxes and fees) to Washington than it got back, or did you state get back more than it gave?

The big and rich states have complained that they are subsidizing other states to the detriment of their own roads, and Senator Kay Bailey Hutchison (R-Tex) has pushed legislation to allow states to opt out of the HTF.

But a new study by the Government Accountability Office (GAO) shows that nearly all states have gotten back at least as much money from the HTF as they contributed since 2005.

Ironically, the lone exception was Texas which received slightly less than a dollar – 99.7 cents – for every dollar its highway users paid into the system. Other states’ returns per dollar ranged from $1.02 for Arizona to $5.63 for D.C. Of the remaining states, only Alaska at $4.92 topped the $4 mark and five states received between $2 and $3 for every dollar of input.

“In addition, all states, including Texas, received more funding than their highway users’ contributed during both fiscal years 2007 and 2008,” said the report. “In effect, almost every state was a donee state during the first fours years of the current transportation law “(SAFEYTEA-LU).

This was possible because more funding was authorized and apportioned than was collected from the states. The reference is to the almost $30 billion of general revenue channeled to the HTF by Congress since 2008 as the fund staved off bankruptcy largely because more funding was authorized than collected.

Current transportation law includes an equity bonus designed to guarantee states a minimum return. The Equity Bonus Program was used to address rate-of-return issues. It guaranteed about $44 billion. Nearly all states received Equity Bonus funding and about half received a significant increase, at least 25 percent, over their core funding. In effect, the bonus balances donor/donee status by disproportionately using the fund to lift donor states up to equity.

If the percentage of funds states contributed to the total is compared with the percentage of funds states received (i.e., relative share), then 28 states received a relatively lower share and 22 states received a relatively higher share than they contributed. Thus, depending on the method of calculation, the same state can appear to be either a donor or donee state, said the report.

But the report also highlights some of the problems that come with general fund infusions and with the requirement that the HTF be tied to a rate of return.

The report notes that the infusion of general revenues into the Highway Trust Fund affects the relationship between funding and contributions. “Using rate of return as a major factor in determining highway funding poses challenges to introducing a performance and accountability orientation into the highway program; rate-of-return calculations in effect override other considerations to yield a largely predetermined outcome – that of returning revenues to their state of origin. Because of these and other challenges, funding surface transportation programs remains on GAO’s High-Risk list.”

The report bluntly highlights a problem: “Adding general revenues into the trust fund and other challenges raise questions about relying on states’ rate-of-return to distribute federal highway funds.”

In addition to outside (general fund) funding, the report identifies two other wild cards that influence the amount and percentage of funds received: One is “the challenge of factoring performance and accountability for results into transportation investment decisions;” and two is “the long-term sustainability of existing mechanisms and the challenges associated with developing new approaches to funding the nation’s transportation system.”

The key to the problem is not hard to find; in fact, the report states it quite succinctly: “… the infusion of significant amounts of general revenues into the Highway Trust Fund Highway Account breaks the link between highway taxes and highway funding.” This is the problem that is worrying lobbyists and associations pushing hard for reauthorization. They fear that if an infusion from the general fund comes to be considered a common practice, then opponents of the HTF will claim the need for it has passed.

There is another problem: “The infusion of a significant amount of general fund revenues complicates rate-of-return analysis because the current method of calculating contributions does not account for states’ general revenue contributions. For many states, the share of Highway Trust Fund contributions and general revenue contributions are different, therefore state-based contributions to all the funding in the Trust Fund are no longer clear.”

The rate-of-return formula poses yet another problem when it comes to trying to factor performance and accountability into transportation investment decisions.

Incorporating performance and accountability for results into transportation funding decisions is critical to improving results. However the current approach presents challenges. Says the report, “…incorporating performance and accountability for results into transportation funding decisions is critical to improving results. However the current approach presents challenges. The Federal-Aid Highway program, in particular, distributes funding through a complicated process in which the underlying data and factors are ultimately not meaningful because they are overridden by other provisions designed to yield a largely predetermined outcome – that of returning revenues to their state of origin.”

In other words, trying to meet the rate of return criteria leaves little or no room to allow for performance and accountability factors. The Washington complaint as the GAO sees it in this report is that once the money is out of their hands they have previous little control over when, where and how it is spent.

So, how do you change that?

Well, the GAO says it’s trying: “For three highway programs that were designed to meet national and regional transportation priorities, we have recommended that Congress consider a competitive, criteria-based process for distributing federal funds.”

The report notes that with, “many surface transportation programs, goals are numerous and conflicting, and the federal role in achieving the goals is not clear. Many of these programs have no relationship to the performance of either the transportation system or of the grantees receiving federal funds, and do not use the best tools and approaches to ensure effective investment decisions.”

Performance and accountability for results must be considered in transportation funding standards. But according to the GAO, the need to return revenues to their state of origin overwhelms that process.

In the end, the report recognizes the inevitable: “A fund that relies on increasing the use of motor fuels to remain solvent might not be compatible with the strategies that may be required to address these challenges.” This of course raised a sequential question: If not the HTF, what? The GAO argues that in the near future policy discussions will need to consider what the most adequate and appropriate transportation financing systems will be and “whether or not the current system continues to make sense.” v

We decry the decrepit state of our “crumbling” infrastructure, but we have yet to adopt legal rules needed to provide for its ongoing maintenance and repair.

A glance at the law governing enforcement of municipal bond obligations suggests a possible strategy for solving the maintenance problem, one that could be developed by state and local officials, bond lawyers, and other financial professionals.

Despite the drift of political and editorial rhetoric, the solution here is probably not to increase federal spending. Rather, it probably lies in the more tedious exercise of changing state and local finance laws nationwide to give maintenance spending the same priority, the same legal protection from political plunder, as debt service. This, even though maintenance spending is usually considered part of the annual operating budget separate and distinct from payments to bondholders.

Typically, bondholders are a “permanent” minority. In James Madison’s terms, they are a “faction” of lenders, always outnumbered by the (debtor) faction of voters. If bondholders had to rely for payment on the annual budget log-roll, they would, like any other permanent minority, almost always lose. They would need constitutional safeguards or other effective protection. Indeed, it’s precisely the existence of constitutional protection — or in some cases, an equivalently sturdy economic incentive — that permits states and localities to attract long-term lenders to finance capital projects.

Throughout the late 19th and most of the 20th centuries, bondholders relied largely on the non-impairment provision of the contract clause of the Constitution (and similar interpretations of state constitutions) for protection of their interests. Courts would generally enforce debt-service payment obligations against states and localities, even in the face of periodic political decisions to the contrary.

In the late 19th century, for instance, the docket of the U.S. Supreme Court was crowded with municipal bond enforcement cases. And not too long ago, in 1977, the contract clause protected covenants barring mass transit spending by the Port Authority of New York and New Jersey in the U. S. Trust case.

For more than a century, legal enforceability induced lenders to bear political risks that could result not only in payment default but also in a covenant breach. The muni bond market flourished and grew.

More recently, as shown by the explosive growth of “subject-to-appropriation” or “back-door” credits — where a legal obligation to pay arises only after an appropriation has been made in the fiscal period when payment is due — bondholders have come to rely on the expected draconian consequences of “repudiation” by a (sovereign) state.

If a state should fail to appropriate debt service for an authorized subject-to-appropriation credit, then, for all practical purposes, the market would consider that to be a repudiation of the state’s own debt. As a result, the state would lose access to credit markets, at least until the repudiation itself was repudiated by full payment. Loss of access is an altogether unacceptable risk, one imposing essentially the same payment discipline as legal enforceability.

For locals, markets generally don’t accept repudiation risk as an effective safeguard for long-term lending, in part because locals are in no relevant sense sovereign in our federal system, and in part because no one can confidently predict what they may do. After all, Los Angeles is now boycotting Arizona, and the West 67th Street Block Association in New York City once had its own foreign policy.

Those factors raise two questions about infrastructure maintenance:

Are supporters of current maintenance those who oppose “deferred maintenance,” a permanent minority in need of constitutional protection in our political system, just like bondholders themselves?

Are special projects like limited-access highways and toll bridges — which produce cash revenue to pay bondholders and where that cash is not normally required to be spent only in the budget appropriation process — in a different analytical position from ordinary infrastructure projects like local roads, bridges, schools, and parks, which produce no cash revenue and where general obligation or other tax-supported bondholders get paid even if the project falls apart?

As to the first question, deferred maintenance is hardly a laudable public-policy goal, despite the pledge of one desperate candidate to be the veritable champion of deferred maintenance. Rather, deferred maintenance is to be avoided if all that crumbling infrastructure is to be avoided.

No one can tell when maintenance is deferred, without granular expertise in capital and operating budgets. As a result, the repudiation risk has no bite. Everyone wants infrastructure to be maintained, but everyone also has multiple higher priorities. No special interest groups or political action committees organize around pro-maintenance slogans. Indeed, interest groups frequently target funds otherwise earmarked for maintenance as a funding source for their own wages, benefits, or transfer payments. Also, few ribbon-cutting photo-ops are held to herald maintenance programs.

So, yes, proponents of current maintenance and opponents of deferred maintenance constitute a permanent minority in need of constitutional protection in the normal budget process.

For the second question, comparing how we finance revenue-generating projects with how we finance ordinary infrastructure suggests a fix. Revenue bond indentures effectively protect maintenance requirements as if they were debt-service requirements by building the former into coverage ratios for the latter. Investors fear projects that are not maintained will fail to generate the requisite revenue to pay debt service.

Generally, no money is released from the lien of a revenue bond indenture unless debt service is paid and operations and maintenance requirements are met. Enforceable covenants require issuers to raise tolls, fares or other charges sufficiently to meet both those requirements.

By contrast, GO and other tax-supported debt instruments are not generally issued with enforceable claims for current maintenance. Ordinary infrastructure projects produce returns in the form of public goods, not cash — public goods that benefit taxpayers, not bondholders. Those projects’ bonds are paid for by taxpayers, not direct users, and taxing and spending for payment are part of the annual budget process, where any pro-maintenance lobby is a perpetual minority.

So, yes, we should consider reconfiguring state and local finance laws, jurisdiction by jurisdiction, to provide the equivalent of debt service protection for maintenance requirements, by authorizing financing mechanisms for ordinary infrastructure that recognize enforceable claims for current maintenance and repair. This would entail authorizing a parallel structure to a revenue-bond financing structure.

The aim here would be for budget-makers to provide for maintenance spending, along with debt service spending, before recognizing other claims on annual revenue. A one-size-fits-all model or uniform law would probably not work for 50 states.

This is not to suggest that maintenance claims are more important than the compelling and competing claims of teachers, police, or sick children. It is, however, to suggest that maintenance claims — like the claims of bondholders — are unlikely ever to be met in the normal political process without structural fiscal safeguards. So, unless we change the rules of the game, we’ll probably have to live with our “crumbling” infrastructure.

Editor’s Note: Eugene W. Harper Jr., a retired New York bond lawyer, teaches infrastructure finance at the Baruch College, City University of New York, School of Public Affairs. This article ran originally in The Bond Buyer newspaper. Bond Buyer is a SourceMedia publication. SourceMedia is owned by Investcorp, which also owns Randall-Reilly, the parent company of Better Roads.

Financial District

The “donor” or “donee” debate still ignites controversy when it comes to the Highway Trust Fund. Did your state ‘donate” (give more in fuel and other highway user taxes and fees) to Washington than it got back, or did you state get back more than it gave?

The big and rich states have complained that they are subsidizing other states to the detriment of their own roads, and Senator Kay Bailey Hutchison (R-Tex) has pushed legislation to allow states to opt out of the HTF.

But a new study by the Government Accountability Office (GAO) shows that nearly all states have gotten back at least as much money from the HTF as they contributed since 2005.

Ironically, the lone exception was Texas which received slightly less than a dollar – 99.7 cents – for every dollar its highway users paid into the system. Other states’ returns per dollar ranged from $1.02 for Arizona to $5.63 for D.C. Of the remaining states, only Alaska at $4.92 topped the $4 mark and five states received between $2 and $3 for every dollar of input.

“In addition, all states, including Texas, received more funding than their highway users’ contributed during both fiscal years 2007 and 2008,” said the report. “In effect, almost every state was a donee state during the first fours years of the current transportation law “(SAFEYTEA-LU).

This was possible because more funding was authorized and apportioned than was collected from the states. The reference is to the almost $30 billion of general revenue channeled to the HTF by Congress since 2008 as the fund staved off bankruptcy largely because more funding was authorized than collected.

Current transportation law includes an equity bonus designed to guarantee states a minimum return. The Equity Bonus Program was used to address rate-of-return issues. It guaranteed about $44 billion. Nearly all states received Equity Bonus funding and about half received a significant increase, at least 25 percent, over their core funding. In effect, the bonus balances donor/donee status by disproportionately using the fund to lift donor states up to equity.

If the percentage of funds states contributed to the total is compared with the percentage of funds states received (i.e., relative share), then 28 states received a relatively lower share and 22 states received a relatively higher share than they contributed. Thus, depending on the method of calculation, the same state can appear to be either a donor or donee state, said the report.

But the report also highlights some of the problems that come with general fund infusions and with the requirement that the HTF be tied to a rate of return.

The report notes that the infusion of general revenues into the Highway Trust Fund affects the relationship between funding and contributions. “Using rate of return as a major factor in determining highway funding poses challenges to introducing a performance and accountability orientation into the highway program; rate-of-return calculations in effect override other considerations to yield a largely predetermined outcome – that of returning revenues to their state of origin. Because of these and other challenges, funding surface transportation programs remains on GAO’s High-Risk list.”

The report bluntly highlights a problem: “Adding general revenues into the trust fund and other challenges raise questions about relying on states’ rate-of-return to distribute federal highway funds.”

In addition to outside (general fund) funding, the report identifies two other wild cards that influence the amount and percentage of funds received: One is “the challenge of factoring performance and accountability for results into transportation investment decisions;” and two is “the long-term sustainability of existing mechanisms and the challenges associated with developing new approaches to funding the nation’s transportation system.”

The key to the problem is not hard to find; in fact, the report states it quite succinctly: “… the infusion of significant amounts of general revenues into the Highway Trust Fund Highway Account breaks the link between highway taxes and highway funding.” This is the problem that is worrying lobbyists and associations pushing hard for reauthorization. They fear that if an infusion from the general fund comes to be considered a common practice, then opponents of the HTF will claim the need for it has passed.

There is another problem: “The infusion of a significant amount of general fund revenues complicates rate-of-return analysis because the current method of calculating contributions does not account for states’ general revenue contributions. For many states, the share of Highway Trust Fund contributions and general revenue contributions are different, therefore state-based contributions to all the funding in the Trust Fund are no longer clear.”

The rate-of-return formula poses yet another problem when it comes to trying to factor performance and accountability into transportation investment decisions.

Incorporating performance and accountability for results into transportation funding decisions is critical to improving results. However the current approach presents challenges. Says the report, “…incorporating performance and accountability for results into transportation funding decisions is critical to improving results. However the current approach presents challenges. The Federal-Aid Highway program, in particular, distributes funding through a complicated process in which the underlying data and factors are ultimately not meaningful because they are overridden by other provisions designed to yield a largely predetermined outcome – that of returning revenues to their state of origin.”

In other words, trying to meet the rate of return criteria leaves little or no room to allow for performance and accountability factors. The Washington complaint as the GAO sees it in this report is that once the money is out of their hands they have previous little control over when, where and how it is spent.

So, how do you change that?

Well, the GAO says it’s trying: “For three highway programs that were designed to meet national and regional transportation priorities, we have recommended that Congress consider a competitive, criteria-based process for distributing federal funds.”

The report notes that with, “many surface transportation programs, goals are numerous and conflicting, and the federal role in achieving the goals is not clear. Many of these programs have no relationship to the performance of either the transportation system or of the grantees receiving federal funds, and do not use the best tools and approaches to ensure effective investment decisions.”

Performance and accountability for results must be considered in transportation funding standards. But according to the GAO, the need to return revenues to their state of origin overwhelms that process.

In the end, the report recognizes the inevitable: “A fund that relies on increasing the use of motor fuels to remain solvent might not be compatible with the strategies that may be required to address these challenges.” This of course raised a sequential question: If not the HTF, what? The GAO argues that in the near future policy discussions will need to consider what the most adequate and appropriate transportation financing systems will be and “whether or not the current system continues to make sense.” v

We decry the decrepit state of our “crumbling” infrastructure, but we have yet to adopt legal rules needed to provide for its ongoing maintenance and repair.

A glance at the law governing enforcement of municipal bond obligations suggests a possible strategy for solving the maintenance problem, one that could be developed by state and local officials, bond lawyers, and other financial professionals.

Despite the drift of political and editorial rhetoric, the solution here is probably not to increase federal spending. Rather, it probably lies in the more tedious exercise of changing state and local finance laws nationwide to give maintenance spending the same priority, the same legal protection from political plunder, as debt service. This, even though maintenance spending is usually considered part of the annual operating budget separate and distinct from payments to bondholders.

Typically, bondholders are a “permanent” minority. In James Madison’s terms, they are a “faction” of lenders, always outnumbered by the (debtor) faction of voters. If bondholders had to rely for payment on the annual budget log-roll, they would, like any other permanent minority, almost always lose. They would need constitutional safeguards or other effective protection. Indeed, it’s precisely the existence of constitutional protection — or in some cases, an equivalently sturdy economic incentive — that permits states and localities to attract long-term lenders to finance capital projects.

Throughout the late 19th and most of the 20th centuries, bondholders relied largely on the non-impairment provision of the contract clause of the Constitution (and similar interpretations of state constitutions) for protection of their interests. Courts would generally enforce debt-service payment obligations against states and localities, even in the face of periodic political decisions to the contrary.

In the late 19th century, for instance, the docket of the U.S. Supreme Court was crowded with municipal bond enforcement cases. And not too long ago, in 1977, the contract clause protected covenants barring mass transit spending by the Port Authority of New York and New Jersey in the U. S. Trust case.

For more than a century, legal enforceability induced lenders to bear political risks that could result not only in payment default but also in a covenant breach. The muni bond market flourished and grew.

More recently, as shown by the explosive growth of “subject-to-appropriation” or “back-door” credits — where a legal obligation to pay arises only after an appropriation has been made in the fiscal period when payment is due — bondholders have come to rely on the expected draconian consequences of “repudiation” by a (sovereign) state.

If a state should fail to appropriate debt service for an authorized subject-to-appropriation credit, then, for all practical purposes, the market would consider that to be a repudiation of the state’s own debt. As a result, the state would lose access to credit markets, at least until the repudiation itself was repudiated by full payment. Loss of access is an altogether unacceptable risk, one imposing essentially the same payment discipline as legal enforceability.

For locals, markets generally don’t accept repudiation risk as an effective safeguard for long-term lending, in part because locals are in no relevant sense sovereign in our federal system, and in part because no one can confidently predict what they may do. After all, Los Angeles is now boycotting Arizona, and the West 67th Street Block Association in New York City once had its own foreign policy.

Those factors raise two questions about infrastructure maintenance:

Are supporters of current maintenance those who oppose “deferred maintenance,” a permanent minority in need of constitutional protection in our political system, just like bondholders themselves?

Are special projects like limited-access highways and toll bridges — which produce cash revenue to pay bondholders and where that cash is not normally required to be spent only in the budget appropriation process — in a different analytical position from ordinary infrastructure projects like local roads, bridges, schools, and parks, which produce no cash revenue and where general obligation or other tax-supported bondholders get paid even if the project falls apart?

As to the first question, deferred maintenance is hardly a laudable public-policy goal, despite the pledge of one desperate candidate to be the veritable champion of deferred maintenance. Rather, deferred maintenance is to be avoided if all that crumbling infrastructure is to be avoided.

No one can tell when maintenance is deferred, without granular expertise in capital and operating budgets. As a result, the repudiation risk has no bite. Everyone wants infrastructure to be maintained, but everyone also has multiple higher priorities. No special interest groups or political action committees organize around pro-maintenance slogans. Indeed, interest groups frequently target funds otherwise earmarked for maintenance as a funding source for their own wages, benefits, or transfer payments. Also, few ribbon-cutting photo-ops are held to herald maintenance programs.

So, yes, proponents of current maintenance and opponents of deferred maintenance constitute a permanent minority in need of constitutional protection in the normal budget process.

For the second question, comparing how we finance revenue-generating projects with how we finance ordinary infrastructure suggests a fix. Revenue bond indentures effectively protect maintenance requirements as if they were debt-service requirements by building the former into coverage ratios for the latter. Investors fear projects that are not maintained will fail to generate the requisite revenue to pay debt service.

Generally, no money is released from the lien of a revenue bond indenture unless debt service is paid and operations and maintenance requirements are met. Enforceable covenants require issuers to raise tolls, fares or other charges sufficiently to meet both those requirements.

By contrast, GO and other tax-supported debt instruments are not generally issued with enforceable claims for current maintenance. Ordinary infrastructure projects produce returns in the form of public goods, not cash — public goods that benefit taxpayers, not bondholders. Those projects’ bonds are paid for by taxpayers, not direct users, and taxing and spending for payment are part of the annual budget process, where any pro-maintenance lobby is a perpetual minority.

So, yes, we should consider reconfiguring state and local finance laws, jurisdiction by jurisdiction, to provide the equivalent of debt service protection for maintenance requirements, by authorizing financing mechanisms for ordinary infrastructure that recognize enforceable claims for current maintenance and repair. This would entail authorizing a parallel structure to a revenue-bond financing structure.

The aim here would be for budget-makers to provide for maintenance spending, along with debt service spending, before recognizing other claims on annual revenue. A one-size-fits-all model or uniform law would probably not work for 50 states.

This is not to suggest that maintenance claims are more important than the compelling and competing claims of teachers, police, or sick children. It is, however, to suggest that maintenance claims — like the claims of bondholders — are unlikely ever to be met in the normal political process without structural fiscal safeguards. So, unless we change the rules of the game, we’ll probably have to live with our “crumbling” infrastructure.

Editor’s Note: Eugene W. Harper Jr., a retired New York bond lawyer, teaches infrastructure finance at the Baruch College, City University of New York, School of Public Affairs. This article ran originally in The Bond Buyer newspaper. Bond Buyer is a SourceMedia publication. SourceMedia is owned by Investcorp, which also owns Randall-Reilly, the parent company of Better Roads.